1. This reference relates to the question whether there is a diversion of income by the assessee before it has reached her hands or whether this is a case where there is application of income by the assessee after it was received by her. The reference relates to the assessment year 1961-62 and the short facts are as under :
By a deed of settlement dated July 1, 1947, Lala Motilal Chimanram Jhunjhunwala, settled upon trust 225 shares of Motilal Padampat Sugar Mills Co. Ltd. of the face value of Rs. 1,000 each for the objects therein stated. By clause 2 of the deed of settlement the settlor directed the trustees to pay the net income from the trust to his daughter-in-law, Kamlabai Juthalal, the assessee for the term of her life, and after her, to hold the corpus of the trust fund upon trust and to divide the same in equal shares amongst all the sons of Juthalal Motilal (grand-sons of the settlor). After some years, on May 5, 1956, by a tripartite deed of assignment and gift, Kamlabai Juthalal, the assessee, who was the beneficiary under the earlier deed of settlement, assigned and transferred her right to receive the income from the trust in favour of four grandsons, Rajendrakumar, Virendrakumar, Gopalkrishna and Mahendrakumar. On these facts the question that arose for consideration which has been referred to for our determination is :
"Whether, on the facts and in the circumstances of the case, the provisions of the deed of assignment dated May 5, 1956, executed by Smt. Kamlabai Juthalal resulted in a diversion of income before it reached her hands or an application of income after it was received by her ?"
2. The Income-tax Officer following his reasoning in a similar case held that the income of the trust should be included in the income of the assessee, Kamlabai Juthalal, for the relevant assessment year. He rejected the contention on behalf of the assessee that income was diverted at source before it reached the assessee as her income and was, therefore, not liable to be regarded as income and to be taxed. In the opinion of the Income-tax Officer the true effect of the deed of assignment and gift was that there was an application of income by the assessee after it was received by her, and, accordingly, it was liable to be assessed in the hands of the assessee. On construing clauses (b) and (c) of the deed of assignment and gift he held that what could be collected by the assignees was the income which would have been received by the assessee but for the deed of assignment. Logically, therefore, it followed that before the assignees could lay their claim, the income must have accrued to the assessee. The assignees could not derive the income direct from the trust without the instrument executed by the assessee. The Income-tax Officer further pointed out that the assessee had no interest in the corpus of the trust; that the properties that were assigned by her came into existence only when the income was found due to her under the deed of settlement dated July 1, 1947. On an appeal by the assessee the Appellate Assistant Commissioner rejected the contention of the assessee and dismissed the appeal. On a second appeal before the Tribunal it was contended on behalf of the assessee that the assessee had done everything that was possible in the circumstances of the case to divest herself of her right to participate in the income from the trust for all time to come and that the income did not pass to the donees through the assessee and hence the transfer amounted to a transfer of the source of income before the income reached her hands. The Tribunal, after referring to the provisions of sections 58 and 69 of the Indian Trusts Act, 1882, held that it was open to a beneficiary to transfer her interest or right to receive the income from the trust in favour of grandsons and the grandsons as assignees had thereafter the right to demand and to receive payment of the income from the trust from the trustees directly and the trustees were bound to pay the income to them and that the assignment in the present case by the assessee amounted to an assignment of the very source of income for two reasons : (1) The assignment was not subject to any conditions, restrictions or limitations such as that the income should be paid to the donees through the beneficiary or for a certain time, etc.; and (2) the trustees had notice of assignment by joining the gift deed as executants and by agreeing to pay the income to the donees. The Tribunal accordingly found that the obligation created by the assessee to pay the income from the trust to the donees under the terms of the deed of assignment and gift was one whereby the income was diverted before it reached her hands.
3. Mr. Joshi on behalf of the revenue contended that the income which has been assigned by the assessee by the deed of assignment and gift dated May 5, 1956, first accrued to the assessee and it was thereafter applied by her in consonance with the provisions of the said deed of assignment and gift. His submission was that there is a clear distinction between obligation to spend money in a particular manner attaching to income and a similar obligation attaching to a source of income; that every income that accrues or arises is liable to be taxed regardless of the distinction; that in the present case having regard to the provisions of the deed of settlement and the deed of assignment and gift, the assessee has not abrogated or assigned the source of income and the income which accrues under the deed of settlement is her own income. His submission was that this is a case of an application of income after it had accrued to the assessee and not one of diversion of the source of income before the income had accrued to the assessee.
4. By a deed of settlement dated July 1, 1947, Lala Motilal settled upon trust 225 shares of a limited company as therein mentioned. The relevant trust with which we are concerned is contained in clause 2 which is as under :
"2. The trustees hereby declare that they shall hold and stand possessed of the said 225 ordinary shares (hereinafter for brevity's sake referred to as "the trust fund")...... upon the trusts following that is to say : -
(a) (This clause dealt with the incidental expenses to be incurred by the trustees before the distribution of the net income was to be made).
(b) To pay and hand over the balance of such dividends, interest, profits and other income to the settlor's said daughter-in-law, Kamlabai, for and during the term of her natural life.
(c) On and after the death of the said Kamlabai, the trustees shall hold and stand possessed of the corpus of the trust fund upon trust to divide the same in equal shares amongst all the sons of the said Juthalal Motilal, their respective heirs, executors and administrators."
5. If this was the only document on which the question to be considered is whether the income of the trust should be regarded as that of the assessee or not, clearly the answer would be that it is the income of the assessee because the net income under sub-clause (b) of clause 2 of the deed of trust is given to the assessee during her natural life. However, on May 5, 1956, a deed of assignment and gift was executed by the assessee as assignor to which the trustees under the deed of settlement dated July 1, 1947, are parties and the donees, i.e., the grandsons through their natural guardian, are also parties as assignees. The recitals in this deed of assignment and gift clearly show that out of natural love and affection which the assignor bears to grandsons being the assignees she, the assignor, is desirous of assigning and transferring her life or other interest in the trust fund in the manner therein indicated. There is a further recital to the effect that the gift and assignment of such life interest is accepted on behalf of the assignees by their father and natural guardians. There is still a further recital to the effect that in view of the assignment and transfer of her life or other interest in the trust fund in favour of the assignees the trustees have agreed to join "in these presents for the purpose of the payment of the net income of the trust fund by them to the assignees in the manner stated in the deed of assignment". The operative part of this deed of assignment says "In consideration of the premises and of the natural love and affection which the assignor bears to her grandsons the assignees and for diverse other good causes and considerations her thereunto moving she the assignor doth hereby assign and transfer unto the assignees all that the net income of the trust fund...... and all the estate right title interest property claim or demand of the assignor into and upon the said net income as aforesaid to have hold receive and take the same unto the assignees for ever absolutely to the intent that the assignees shall be entitled to receive from the date of these presents form the trustees for the time being of the said deed of settlement the net income of the trust fund or the investments thereof which the assignor would have received but for the present assignment and transfer during her life time."
6. It is quite clear form the provisions of the initial deed of settlement dated July 1, 1947, that the assessee was entitled to the net income for her life and after her life the entire corpus of the trust fund was to be divided amongst the grandsons who are the assignees in the later deed. Section 9 of the Indian Trusts Act permits a beneficiary to renounce his or her interest under the trust by disclaimer addressed to the trustees. Further, section 58 of that Act permits a beneficiary who is competent to contract to transfer his or her interest. Section 69 of that Act provides that every person to whom a beneficiary transfers his or her interest has the rights, and is subject to the liabilities of the beneficiary in respect of such interest at the date of the transfer.
7. Whether a particular case is one where there is a diversion of income at source before it has accrued to the assessee, or whether it is an application of income by the assessee after it has accrued or arisen to him or her, the true test is laid down in more than one decision of the Supreme Court. In Commissioner of Income-tax v. Sitaldas Tirathdas , Hidayatullah J., who delivered
the judgment of the court, has laid down the true test in the following words :
"In our opinion, the true test is whether the amount sought to be deducted, in truth, never reached the assessee as his income. Obligations, no doubt, there are in every case, but it is the nature of the obligation which is the decisive fact. There is a difference between an amount which a person is obliged to apply out of his income and an amount which by the nature of the obligation cannot be said to be a part of the income of the assessee. Where by the obligation income is diverted before it reaches the assessee, it is deductible; but where the income is required to be applied to discharge an obligation after such income reaches the assessee, the same consequence, in law, does not follow. It is the first kind of payment which can truly be excused and not the second. The second payment is merely an obligation to pay another a portion of one's own income, which has been received and is since applied. The first is a case in which the income never reaches the assessee, who even if he were to collect it, does so, not as part of his income, but for and on behalf of the person to whom it is payable."
8. To the same effect is the ratio of the decision of the Supreme Court in Commissioner of Income-tax v. Imperial Chemical Industries (India) (P.) Ltd. . The Supreme Court there held that an
obligation to apply the income in a particular way before it is received by the assessee or before it has accrued or arisen to the assessee results in the diversion of income. An obligation to apply income which has accrued or arisen or has been received amounts merely to the apportionment of income and the income so applied is not deductible. The true test for the application of the rule of diversion of income by an overriding title is whether the amount sought to be deducted in truth never reached the assessee as his income.
9. We have to consider in the present case the effect of the deed of assignment and gift executed by the assessee on May 5, 1956. As pointed out in sections 58 and 69 of the Indian Trusts Act a beneficiary who is competent to contract can transfer and assign his or her interest under a trust in favour to any other person and the transferee is entitled to such interest subject to any liability which a might have been imposed under the deed of settlement. By the deed of assignment and gift the assignor has clearly transferred the entire net income of the trust fund to the assignees. This is clearly a gift and it has been accepted on behalf of the assignees who are minors by their father and natural guardian. The deed of assignment and gift is executed not only between the assessee as assignor on the one hand and the assignees on the other but the trustees are also parties thereto. Even the trustees have undertaken an obligation under this deed of assignment to pay the net income of the trust fund directly to the assignees. Thus, it is not possible for us to take the view that upon a proper scrutiny of the provisions of the deed of assignment and gift income first accrued or arose to the assessee or was received by her and thereafter applied by her in favour of the grandsons of the settlor. This is clearly a case where there is a complete diversion of the source of income before it accrued or arose to the assessee or was received by her. As the deed of assignment and gift is a tripartite document it will not be permissible to the trustees even to pay any part of the net income to the assessee because she has completely divested herself of her right to receive the money. Thus, it is not possible for us to take the view that the assessee had first received the income and thereafter applied it in favour of the grandsons. In our opinion, the Tribunal was right in taking the view that in the present case the income was diverted before it reached the assessee's hands. Thus, the answer to the question referred to us is as under :
The provisions of the deed of assignment dated May 5, 1956, executed by Kamlabai Juthalal resulted in diversion of income before it reached her hands. The revenue shall pay the costs of the assessee.